Earnings Call Transcript - PAHC Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for being here. Welcome to the Phibro Animal Health Corporation Q4 2020 Conference Call. All participants are currently in a listen-only mode. Following the presentations, there will be a question-and-answer session. I would like to now hand the call over to Richard Johnson, CFO. Please proceed.

Richard Johnson, CFO

Thank you, operator, and good morning, everyone. Welcome to the Phibro Animal Health earnings call for our fourth quarter and fiscal year ended June 2020. On the call today are Jack Bendheim, our Chief Executive Officer, and I am Richard Johnson, Chief Financial Officer. We will provide an overview of our quarterly and full year results, and then we will open the lines for your questions. Let me remind you that the earnings press release and financial tables can be found in the Investors section of our website at pahc.com. We are also providing a simultaneous webcast of this morning's call, which can be accessed on the website as well. Today's presentation slides, along with a replay and transcript of the call, will also be available on the website later today. Our remarks today will include forward-looking statements, and actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, please refer to the forward-looking statements section of our earnings press release. Our remarks today will also include references to certain financial measures that were not prepared in accordance with generally accepted accounting principles or U.S. GAAP. I would direct you to the non-GAAP financial information section in our earnings press release for a discussion of these measures. Reconciliations of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures are included in the financial tables that accompany the earnings press release. Before we get into the numbers, I want to remind everyone that we present our results on a GAAP basis and on an adjusted basis. Our adjusted results exclude acquisition-related items, unusual non-operational or nonrecurring items, certain other income and expense items, and related income tax effects for those pre-tax adjustments, as well as any unusual or nonrecurring income tax items. Now, here is Jack Bendheim with some introductory comments. Jack?

Jack Bendheim, CEO

Thanks Dick. And thank you everyone who is joining us on this call today. The June quarter was certainly a difficult one for Phibro, as it was for all those who are involved in supply chain to feed the world with healthy proteins. We did however highlight our continuing evolution to a more balanced Animal Health company, as despite the incredible challenges we and our customers face across the board, we were able to grow our nutritional specialties for vaccine product lines. We are happy to turn the page. And while we enter our new fiscal year without the typical visibility we would normally have, I do anticipate the macro trend of our nutritional specialties and vaccine products growing at a faster rate than our MFAs and other products will continue. We have a number of growth initiatives relating to our nutritional specialties and vaccine product offerings planned for the current year. Already in the first two months we have seen successes executing against these plans. And I'm confident that our momentum will continue to grow throughout the year as we access new customers and enter new geographies. Over the coming fiscal year, we expect our market to gradually rebound to pre-COVID levels. And importantly, we also anticipate gaining greater personal access to our customers, access that will allow us to resume the work on the multiple new initiatives that were paused by the pandemic. While we are adding a number of new initiatives on top of the ones we are carrying forward from last year, we are cognizant of the need for our industry to get back on its feet. So we're exercising caution in a number of projects we have greenlighted. Finally, I want to reiterate our commitment to stand behind our products. As we stated in our recent press release regarding carbadox, we are deeply disappointed that the FDA has not followed its own procedures and afforded Phibro's hearing, as the law requires and that the FDA previously agreed to. We will continue to work on highlighting the safety and efficacy of this product, and we will take whatever steps are necessary to make sure the product is judged on the science. With that, I will turn it back to Dick and look forward to taking your questions at the conclusion of his presentation. Dick?

Richard Johnson, CFO

Thank you, Jack. So let's start by reviewing the results for our June quarter. Our consolidated sales for the quarter were $186 million, a decline of $18 million or 9% versus the prior year. During the quarter, we experienced a short-term decline in demand for our products due to the pandemic. The animal production industry faced unprecedented demand disruptions, production impacts, price declines, plus substantial currency volatility in a number of international markets. We experienced sales declines in all three segments of our business, primarily due to lower volumes. In Animal Health, we saw increased sales in nutritional specialty and vaccine products, but those were partially offset by the lower sales of MFAs and other products. We'll get into further details regarding segment results later in the presentation. Our reported net income was $5.6 million for the quarter, which was a decline of $3.2 million or 36% compared to the prior year. Income before income taxes improved, primarily due to restructuring costs in the same quarter last year. However, an unusually higher provision for income taxes caused the net income decline. The increase in income tax was driven by the effects of the complex additional federal income tax known as GILTI, that's an acronym changes in uncertain tax positions, and the absence of tax benefits on the operating results of some of our newer international operations. As a result, diluted earnings per share was $0.14 for the current quarter, a decrease of $0.08 per share from the prior year. Now let's look at adjusted results. In total, adjusted gross profit was $62.1 million for the quarter. That was a decline of $4.5 million or 7% compared to the prior year. We did see favorable product mix in the Animal Health and nutrition segments during the quarter and that contributed to an improvement in the overall gross profit percentage. In the Animal Health segment, increased sales and gross profit from nutritional specialty and vaccine product sales partially offset lower volumes in MFAs and other products. Mineral Nutrition gross profit decreased as lower average selling prices more than offset favorable raw material costs, and the gross profit decline in Performance Products was driven by lower overall volume. Total adjusted SG&A or operating expenses decreased in the quarter to $44.2 million, a decrease of $1.7 million or 4% year-on-year, primarily due to lower variable compensation and employee-related costs in the Animal Health segment, with a partial offset from the effects of the Osprey acquisition. This is the last quarter where we will see any meaningful impact of the overlap of the acquisition which we did in August a year ago. The adjusted provision for income taxes was unusually high in the quarter for the same reasons that I described earlier. As a result, adjusted diluted EPS was $0.17 per share compared with $0.30 per share last year. Looking more closely at the Animal Health business, net sales of $122 million declined $9.6 million or 7% compared to the same period of the prior year. Net sales of nutritional specialty products were $31.1 million, an increase of $2.6 million or 9%. The Osprey acquisition accounted for the majority of that sales growth. Net sales of vaccines were $18.6 million, an increase of $1.5 million or 8%, driven by higher international demand. And net sales of MFAs and other products were $72.6 million, a decline of $13.7 million or 16%. We saw lower demand in various international regions, including China and South America, and the volume decline in China was due to the effects of African Swine Fever plus a phased regulatory change that took effect in the middle of our fiscal year in January of 2020. For the Animal Health segment, adjusted EBITDA was $29.6 million, which was a decline of $1.6 million or 5%. The decrease was attributable to the overall sales and related gross profit decreases, partially offset by favorable SG&A costs. Looking at our other segments, the Mineral Nutrition had net sales of almost $50 million, which was about a $6 million decrease or 11% due primarily to lower average selling prices coupled with slightly lower overall unit volumes. The lower average selling prices are generally correlated with the movement of underlying raw material costs. Gross profit declined $300,000 in the quarter as the decline in average selling prices was more than the change in favorable raw material costs. Adjusted EBITDA was $3.5 million, down about $300,000 compared with the same quarter last year. The Performance Products business reported net sales of $13.6 million, also a decline of $2.3 million or 14%. We saw volume declines in copper-based industrial chemical products, which contributed to lower profitability and an overall $400,000 decrease in adjusted EBITDA. Corporate expenses were comparable to the prior year. Now, turning briefly to our full year performance, we not only are talking about the quarter but talking about the full year. So, for the full year, we have $800 million of sales, which was about a 3% year-over-year decline. Within the Animal Health segment, sales declined about $5 million, which was approximately 1%. We did report double-digit sales growth for our nutritional specialty and vaccine product lines. However, MFAs and other products declined. Our net sales of nutritional specialties grew 14% for the full year due to volume growth in poultry and dairy products. The recent Osprey acquisition accounted for approximately two-thirds of the overall sales growth for that product group. Vaccines grew 10% for the full year due to strong international demand for poultry vaccines and increasing market penetration. In addition, in the prior year, we had a domestic distribution arrangement for the first four months of the year, and so on a comparable basis, our net sales of vaccines would have increased 14% without that unfavorable overlap. Finally, net sales of MFAs and other products declined 8% due to a $31 million sales decline in China driven by the effects of African Swine Fever and regulatory changes. The other segments of our business also saw declines in sales. Mineral Nutrition segment declined $19 million that was an 8% decline, primarily driven by lower average selling prices. Performance Products net sales decreased $3 million or about 5% due to reduced volumes of copper-based products with a partial offset from more business in the personal care ingredients area. Adjusted gross profit overall was $263.5 million, which declined $6.4 million or 2% due to the sales and related gross profit declines. Animal Health adjusted gross profit declined primarily due to the sales decline in MFAs and other products with some partial offset from the sales growth in the other product groups. Mineral Nutrition adjusted gross profit also declined as we saw average selling prices dropping slightly faster than the overall favorable raw material costs and the favorable effect of increased unit volumes, and in Performance Products, gross profit declined due to lower overall volumes. Total company for the full year adjusted SG&A increased $11.5 million or 7% as we continued to invest in product development and strategic initiatives. In addition, the Osprey acquisition and increased public company costs related to strengthening and testing of internal control over financial reporting also contributed to the overall expense increase. As a result, adjusted EBITDA for the year was $102 million compared to $118 million a year ago, which translated to adjusted earnings per share of $1.08, a 29% decline compared to $1.53 a year ago. Briefly looking at capitalization, at the end of June, we had a gross leverage ratio of 3.8 times. That was $388 million of total debt compared to $102 million of adjusted EBITDA. We also had $91 million of cash and short-term investments on the balance sheet at that same point in time. For the June quarter, we used $6 million of cash before financing activities primarily for our ongoing capital expenditure program. For the full year, we used $30 million of cash excluding change in short-term investments, which included using $55 million for the acquisition of Osprey. Putting aside the acquisition of Osprey, we generated $25 million of cash prior to any financing activities for the year. We have paid and declared to be paid the routine quarterly dividend of $0.12 a share. Now talking a little bit about our guidance. We are forecasting only short-term expectations at this point given the ongoing difficult conditions in the industry. Our more limited visibility than we would normally have. The animal production industry continues to face demand disruption and production impacts. We are optimistic; we believe the current situation will normalize as we progress through our fiscal year and the industry gradually will return to typical operating levels. Our guidance for our September quarter is to have net sales of approximately $190 million, which is about the same level as the September quarter a year ago. That will translate to net income of $5 million to $6 million on a GAAP basis, an increase of $2.5 to $3.5 million compared to last year and GAAP EPS of $0.13 to $0.15 per share, again an increase of $0.07 to $0.09 per share. Adjusted EBITDA, we are guiding to approximately $20 million for the quarter, again approximately equal to the prior quarter, translating to adjusted diluted EPS of $0.18 to $0.20 per share – a change of $0.01 from the same quarter last year. That’s the end of my prepared comments. We will open it up for questions.

Operator, Operator

Your first question comes from Balaji Prasad with Barclays. Your line is open.

Balaji Prasad, Analyst

Hi. Good morning, everyone. Thanks for taking the questions. Firstly on the guidance, I wanted to draw your attention to last week's report outlook from the USDA which states that it expects poor production of around 7.2 billion pounds, around 7% growth versus last year. Could you please help me understand that outlook with regard to your Q3 guidance? Secondly, with regard to China, can you give an update on what is the current impact of ASF? Isn't the repopulation or re-herding in China taking up pace enough to start offsetting the impact of ASF? Thank you.

Jack Bendheim, CEO

Thanks for the questions. First of all, as we all know, the hog production in the U.S. was greatly disrupted by COVID infections at the processing factories, which forced many of these facilities to close down or operate at different rates. This has pushed back in this past year as a lot of pigs went unprocessed. There were lots of culling and an assortment of products may have moved to different markets. I think the USA is projecting things will get back to normal. Even though some of these plants are still operating, we still understand there are high levels of COVID, which continue to impact operations. I don't think there is a large amount of backlog or excess supply left. So, I think we will see some level of increase in hog production this coming year. As far as China goes, there is no ASF vaccine yet. The way the Chinese producers are combating ASF is by cautiously improving biosecurity measures and moving into larger farms where they can manage the risks. There is an increase in hog population, but many of the smaller farms are hesitant to repopulate due to the risks of significant losses without a vaccine. So, there is some increase, but I don't think they will ever be able to get back to the 400 million pigs they previously had until a vaccine is developed.

Balaji Prasad, Analyst

Thank you.

Operator, Operator

Your next question comes from David Westenberg with Guggenheim Securities. Your line is open.

David Westenberg, Analyst

Hi. Thank you for taking my question. I know you made some investments in this last fiscal year in terms of new product development. Can you talk about the contribution from new products in 2021, whether quantitative or qualitative? And how do you feel your position is in the new precision livestock farming paradigm? Are any of these investments in new products around technology solutions? I have a couple of follow-ups.

Jack Bendheim, CEO

Starting with technology, one of our investments in new technology is a more precise vaccinator for vaccinating chicks. We have developed that product. However, the challenges of the pandemic have severely limited our ability to get on farms and demonstrate this product. While we've made investments and continue to do so, the ramp-up will be slow until there is a COVID vaccine and people feel more comfortable working with sales representatives.

David Westenberg, Analyst

Yes, okay. Got it. That makes sense. So, perhaps we should think about the contribution of products coming after a COVID vaccine, or at least when sales channels are a bit more open. I do note that you're the only company I cover that has Mineral Nutrition as a major business area. Can you remind us about the fluctuation in prices? Why isn't there a way to be more opportunistic given your sophistication as a buyer compared to the companies and farmers you are selling to? Thank you.

Jack Bendheim, CEO

I'll respectfully argue that our customers, the farmers, are quite sophisticated in pricing and raw materials themselves. They are the market's first traders. Prices fluctuate based on many factors, and when global commodity prices change, our customers promptly adjust their practices accordingly. The recent quarter has resulted in a lot of imbalances due to COVID, where farmers couldn't move their livestock normally, leading them to cut back on feed expenditures. Overall, we are returning to a more normalized state, and we feel optimistic about trends in the industry.

David Westenberg, Analyst

That was a really good answer. Thanks, Jack. I’ll leave it there.

Operator, Operator

Your next question comes from Michael Ryskin with Bank of America. Your line is open.

Michael Ryskin, Analyst

Hey, Jack. Thanks for taking the questions. Hope you are doing well. I want to have a couple of quick ones. One, I want to start on the guidance for 1Q and the outlook. I realize there's a lot of uncertainty in the market due to the underlying conditions, particularly with COVID. But fiscal 4Q versus fiscal 1Q guide implies a bit of improvement in the markets. I want to understand the bigger drivers and the U.S. versus international balance regarding COVID impact and whether it's a particular business line or species that is influencing fiscal 1Q?

Jack Bendheim, CEO

Part of it is that we see steadiness in our dairy business due to stable milk prices providing farmers with confidence. Although getting onto farms remains a challenge, we can still communicate with customers and share product information. We are observing growth in our dairy operations, and also seeing new poultry products enter the market, along with consistent growth in our vaccine business. Customers are managing supply chains better and are selling more to supermarkets than before. This optimistic tone contributes to our expectations moving forward.

Michael Ryskin, Analyst

Great. Thanks. Regarding international markets, specifically South America and Latin America, have those markets bottomed out, or is it too early to say, considering the uncertainty linked to COVID?

Jack Bendheim, CEO

While I don’t like to predict bottoms, it appears that the major markets in South America, particularly Brazil and Argentina, are stabilizing. The situation in smaller markets, such as Chile and Peru, remains unpredictable due to COVID. However, the greater concern in the Far East regions like Indonesia and Bangladesh arises from economic downturns affecting populations' ability to purchase protein, not just health-related issues. So, their recovery may take a longer time from the COVID-related impacts.

Michael Ryskin, Analyst

Great. Thanks. A couple of quick questions. Apologies if I missed it earlier, but could you remind me of the timeline and catalysts for Mecadox? And could you also quantify the dollar contribution of Osprey for the year?

Jack Bendheim, CEO

Regarding Mecadox, the FDA surprised us with a decision that did not follow the expected procedure. We are mounting a defense, likely resulting in litigation. I can't provide a short-term prediction, but we are confident about its scientific validity and safety. As for the Osprey acquisition, it contributed approximately two-thirds of our nutritional specialty growth for the year, indicating its significant impact.

Richard Johnson, CFO

Yes, we can say that about two-thirds of our nutritional specialty growth for the year was due to the Osprey business, which should give you a sense of that contribution.

Michael Ryskin, Analyst

Perfect. That’s exactly what I want to see. Thanks so much. Thanks, Richard.

Richard Johnson, CFO

Thank you.

Operator, Operator

Your next question comes from David Risinger with Morgan Stanley. Your line is open.

David Risinger, Analyst

Thanks very much. Good morning, Jack and Dick. I have three questions. First, with respect to China, is there an opportunity for the company to begin to regenerate sales there? Could you talk about those prospects? Second, regarding Brazil, is there anything to watch with respect to virginiamycin regulation? And third, Dick, could you frame medium to long-term prospects for the corporate tax rate?

Jack Bendheim, CEO

In China, we need to get our therapeutic claim for virginiamycin to rebuild our sales, but progress has been slow due to COVID severely impacting governmental procedures. We are now focusing on strengthening our nutrition product sales there as we work towards regaining a foothold. In Brazil, we’ve transitioned virginiamycin from a growth promotion to a therapeutic model, and we are consistently observing sales growth across poultry, swine, and cattle species. Regarding the tax rate, I would say we expect the rate to be below 30% in the medium-term, probably in the upper 20% range on an adjusted basis.

David Risinger, Analyst

Thank you, gents.

Operator, Operator

Your next question comes from Kevin Kedra with G. Research. Your line is open.

Kevin Kedra, Analyst

Hi. Thanks for taking the questions. First, I'd like to ask about inventory levels in the channel after COVID created some disruption. Have we seen that start to normalize, or is there still a lot of movement?

Jack Bendheim, CEO

Globally, inventory levels are pretty balanced at this point. The U.S. had a significant backlog due to issues with processing plants during COVID. When we look at the hog industry, our estimates suggest that the backlog has largely cleared, and production is stabilizing.

Kevin Kedra, Analyst

Appreciate the color. Lastly, did you provide a dollar contribution from carbadox for the full year?

Richard Johnson, CFO

Yes, we mention that in the 10-K. It was $17 million for the fiscal year.

Kevin Kedra, Analyst

Okay. Great. Thanks for that. Any update on what you are doing regarding the African Swine Fever vaccine?

Jack Bendheim, CEO

The pandemic has slowed down our work on the African Swine Fever vaccine, blocking our ability to test products in China. While we continue developing the vaccine outside of China, we hope to move forward as travel restrictions ease and we can access our sites.

Kevin Kedra, Analyst

Okay. Thanks.

Operator, Operator

There are no further questions. At this time, I'll turn the call back over to Richard Johnson for closing remarks.

Richard Johnson, CFO

Well, we thank everyone for listening and your insightful questions and comments. We'll talk to you again when we discuss our first-quarter results in early November. Thank you everyone, and talk next time. Bye.

Operator, Operator

This concludes today's conference call. You may now disconnect.